Bond Trading and Blockchain

I am in fintech space responsible for platforms that trade bonds. I am starting to consider how blockchain technology can be used to facilitate the transfer of securities aspect from a buyer to seller.

Here is the business scenario (expressed simply):

1. Buyer meets Seller through an electronic platform. This is not as trivial as hitting a price on a screen as is the case in Equity or FX markets. There are number of Request-For-Quote, Order Based and Crossing systems that are designed to generate a trade between two parties whilst attempting to minimize the information leakage to the wider market in the process.

2. For this scenario I am assuming buyer has found a seller without a broker intermediary through a crossing platform. Each party to the trade doesn't know the other party is i.e. it is totally anonymous. The crossing platform in my scenario has two functions. Firstly it enables each party to find the other and agree on the trade details. Secondly it is responsible for ensuring the security is transferred between two parties on the terms agreed to. The secondary aspect can be referred to as 'clearing'.

3. Both parties have to trust the platform and the platform in return has to trust the parties. It is possible for a party to sell something which they don't have (this is called shorting). In that case the platform has to 'make good' on the trade to the buyer who is expecting delivery of the bond. The process to do this is complicated and costly to the platform.

Given the very brief description above I am interested in initial thoughts on how Ethereum and Blockchain technology in general could result in a 'better' platform to facilitate the trade. I would qualify better as one satisfying the following:

- Ensuring that the buyer can trust the seller has the bond prior to the trade being agreed.
- Facilitate non-reputable trust between everyone involved i.e. the parties and the platform.

In essence if this is somehow possible the clearing aspect of the platform can be collapsed this leading to monetary savings for each party involved.

Keen on thoughts / questions to help progress this.

JK


Comments

  • mids106mids106 Member Posts: 188 ✭✭✭
    1) The Whisper system might be usable for facilitating this matching process, at least partially. But as you said great attention needs to be paid to minimize information leakage.

    2) While both parties are anonymous; they need to have at least an Ethereum account (the address of which is derived from their public key, for example 52f66c5d100104f907351f39f3d8a19b5535fe85). You can create multiple of such accounts, but their track record is available to everybody once they interact with contracts on the blockchain.

    Trade details could be formalised as part of an Ethereum contract, locking in all bond features. This could include an escrow mechanism where the potential buyer demonstrates that they have the required funds. The seller could have a 3rd party verified proof that they currently own the underlying security.

    A big difference here will be if the actual bond underwriting itself is performed on the blockchain, or if this is merely an interface to the existing financial system. Interaction with the outside world will require trusted third parties; if the bond market itself would be fully performed on chain you can interact with the bond market contract to demonstrate proof of ownership.

    3) Trust here means that everybody has to abide by the rules (executable contract code) as enforced by the Ethereum blockchain and its clients. In case of shorting you'd have to take a security deposit to be able to meet margin requirements. Maybe one could insure against margin calls with a third party contract? This would defer collection to an outside process, reducing the complexity and risk of the bond trading system itself.


    In this case the main advantage of using Ethereum and blockchain technology will be from having multiple independent contracts, easy optimised & responsible for a piece of the system, direct & automated interaction with underlying currency and execution to the letter of smart contracts (but including its flaws and bugs).

    Using this while trying to interface with the existing financial system will only have limited benefits (require several trusted third parties, abiding to regulations that don't match the system). Biggest gain will probably when then entire bond market itself will be performed on chain.
  • jklondonjklondon Member Posts: 4
    Nice response, thanks for you thoughts.

    I am coming to the same conclusion. I think the technology could be applied to various parts of the existing process but I would question the payback.

    The real benefit would come if the securities (bonds in this case) were actually issued in the chain, if this could happen and then all trading was performed in reference to that chain. That could transform the entire market in revolutionary way.
  • caylorcaylor Member Posts: 25 ✭✭
    That's a constant theme in terms of Ethereum. Any contract that resides on the network will be game-changing for the industry/space that it exists within. Shares, bonds, currencies, mortgages, etc. The tough part is getting people to move to the blockchain initially.

    Any new company with shares to issue could promote this by issuing them via the blockchain. Voting rights, and everything else that goes along with shares, could be written into the contracts.

    Perhaps initial adoption, such as this, would help convince others.
  • dbeck74dbeck74 Member Posts: 1
    edited August 2015
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